FEATURE: Take-or-pay – boon or curse for Australia’s coking coal market?

In Australia, infrastructure projects are largely financed on the back of take-or-pay contracts. Under such agreements, junior producers sign up port and rail capacity for which they must pay, whether they use it or not.

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Ironically, however, onerous take-or-pay contracts that lock producers into an expense which cannot be downgraded could prove to be a bonus to the coking coal sector in the long run.

“There is no doubt that producers are continuing to produce coking coal even when it is uneconomic, because of the financial burden of the take-or-pay deals,” one producer told Steel First.

“If they were not carrying these contracts on their books, there is no doubt that production at many mines would have been scaled back months ago,” he added.

Ensured access
Take-or-pay contracts are invaluable to producers when prices and demand are good, as they ensure infrastructure access.

With Australia’s premier coking coal producing region, the Bowen Basin, some hundreds of kilometres from port and accessible only by rail, access such as this is as good as money in the bank – when demand and prices are good.

Producers which have excess capacity can still cash in on the contracts by selling their capacity to other producers.

However, when demand is depressed, producers are reluctant to relinquish their take-or-pay contracts as they run the risk of being locked out of the system.

In short, it is better to pay for the capacity and not use it, than to lose it and be locked out of the market when prices and demand improve.

Driving forces
“There are two driving forces for producers right now, outside of demand and prices,” a former employee with a major producer said.

“Companies are ramping up production to help reduce their per-unit costs, but the take-or-pay contracts are also, to some extent, artificially propping up production,” he said.

“Producers have been taking the hit to their bottom line in order to retain infrastructure access. While this has been a financial burden in recent months, it also places them in a good position to take advantage quickly of any uptick in demand. Producers need to be an optimistic lot,” he added.

“But if prices don’t recover substantially, and soon, you have to expect that there will indeed be production cutbacks at standard-quality operations,” he concluded. “You can only take a loss for so long.”

Market sources have warned that high-cost, standard-volatility coking coal operations were in real danger of having to cut back production sooner rather than later. Many junior miners fall into that bracket.

“At the moment, for the larger producers, the large mines are shouldering the losses being incurred by their smaller mines,” a broker said. “It is obvious in this market, under this scenario, that the juniors have quite simply no chance of getting [projects] up right now.”

‘No chance’
Mitch Jakeman, associate director at China House Consultancy, agrees with this conclusion.

“Greenfield projects have no chance in this market,” Jakeman said, adding that the squeeze on the sector had seen a number of quality coking coal assets put up for sale.

“Juniors need to have a really good coking coal product or there is no point progressing with their projects,” a miner said. “A lot of projects have been shelved by the majors, and I don’t see a lot of movement from the juniors to get their projects up.”

Junior miners contacted by Steel First declined to comment.

“The juniors will keep talking-up their projects because they have to – and they should,” the broker said.

“But you really have to take what the juniors say with a grain of salt, because it’s not a good market for them and they are obviously trying to promote their business,” he added.

“It simply is not a market conducive to getting a new project up,” he concluded. “The economic fundamentals simply do not support it.”